- Marcus Brookes
- 18 February 2020
- 5 minutes
How investors can respond to the coronavirus
The coronavirus has led to hundreds of deaths among the thousands of confirmed cases. It has also had a secondary effect on the global economy. One of the effects has been to send stock prices down, affecting the pensions and investments that many people hold across the world.
So, from an investment perspective, how do I believe people should respond to an event such as the coronavirus outbreak?
The short answer could well be “do nothing”.
Here’s the longer answer.
Swans and tails
The coronavirus is an example of what some investors refer to as a “black swan” event. It’s also referred to as a “tail-risk”.
These fancy terms boil down to something happening that is rare, difficult to anticipate and highly disruptive. The term “black swan” was made popular by Professor Nassim Nicholas Taleb in his book, “The Black Swan: The impact of the highly improbable”. The thinking was that a black swan is rare and highly unpredictable. I’m not sure that black swans are any more unpredictable than white ones, but that’s the world of financial theory for you.
Tail-risk is based on a similar line of thinking but underlined by statistical theory. The likelihood of things happening in future is mapped out on a graph such as the one below.
This hypothetical chart shows how the term “tail-risk” came about. The most likely or “average” height is shown by the peak in the curve, i.e. the highest number of people who are that height. The least likely heights are shown by far fewer people who are either very tall or very short. The least likely heights occur at the tail ends of the graph. So there is a much lower “risk” of things happening at those ends of the chart.
Now that we have an understanding of what these events are, what can we do about them?
What can we do about unlikely events?
I said “nothing” at the beginning of this piece, because the investment preparation for such events should already have been done before the event occurs.
In other words, I believe that the best solution is to have a carefully planned portfolio and the willingness to accept that, from time to time, things come along and cause relatively short-lived disruption.
If the portfolio has been built with a diversified range of investments (e.g. a mixture of stocks, bonds and alternatives such as property), then unexpected events might send the value of some investments down, but others might rise and help limit the loss of value across the portfolio as a whole.
That’s why, when stocks or bonds fall in price, we don’t make major changes to the investment portfolios that we manage. We have a long-term view and spend a huge amount of time and effort building portfolios that are designed to withstand short-term knocks.
But this is the point at which patience may be needed. This will of course depend on an investor’s individual circumstances, however, the majority of investors need to stay focused on the long-term investment horizon. By this we mean 10 years or more. So not panicking is one of the key skills that an investor should hold.
Forecasts of future performance are not a reliable guide to actual results in the future; neither is past performance a reliable indicator of future results. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed and the investor might not get back their initial investment,
Any views expressed are our in-house views as at the time of publishing.
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